Eurozone crisis hangs on ECB cash injection

The next turn in the eurozone debt crisis hung on a massive cash injection by the European Central Bank on Wednesday which governments and financial markets hope banks will use to buy bonds.

Stock markets — which had already closed sharply higher on Tuesday as strong US and German economic data plus a successful Spanish debt sale — rose at the start of trading.

London’s benchmark FTSE 100 stock index rose 0.76%, Frankfurt’s DAX 30 jumping 1.22% and in Paris the CAC 40 gaining 0.81%.

Tension on the eurozone bond and interest rate markets has eased sharply in the last two days.
Positive sentiment was being driven by a new measure by the ECB to pump liquidity into the markets, analysts said.

Many eurozone governments are having great difficulty in borrowing money on the bond market, and next year eurozone governments must sell huge amounts of bonds to finance their mountains of debt.

As announced by ECB chief Mario Draghi last week, the central bank is launching its first-ever 36-month refinancing operation, which will effectively make as much funds as banks want available at just 1.0% for a three-year period.

Draghi announced the measure along with a relaxation of the rules regarding the collateral required from banks as guarantees for loans from the central bank and a reduction in the ratio of reserves that banks must hold at ECB, also freeing up much-needed capital.

Analysts said they are forecasting large demand for the eurozone’s longest-ever refinancing operation, with estimates ranging from €100-billion to €500-billion ($131-billion to $655-billion).

The previous record was €442-billion at an auction for one-year funds in June 2009.

In the run-up to the auction, Spanish and Italian bond yields — both for long and short maturities — have declined significantly, pointing to easing tensions, said Berenberg Bank senior economist Christian Schulz.

Spain’s 10-year sovereign yield fell below 5.0% for the first time since October, while Italy’s has fallen by 0.75% point to 6.5% since last week.

And yields had dropped even more at the shorter end of maturities, Schulz said.
“The auction is driving positive sentiment,” the analyst said.

“Banks may be acquiring eligible collateral ahead of the auction, driving down yields. They may even use some of the extra liquidity from the auction for further purchases of government bonds and step up real economy lending, locking in low refinancing costs.”

Analysts at Moneycorp said there was “high excitement” about the auction, which was effectively offering banks as much free money as they wanted.

Ostensibly, the purpose was to avoid a credit crunch resulting from banks’ reluctance to lend to one another.

“However there is a suspicion, even an expectation, that banks will load up with three-year money at 1.0% and lob it into three-year Italian government bonds at 5.0% or whatever,” the analysts said.

In contrast to previous long-term financing operations have seen only modest demand, recently, the brand-new three-year operation was different because it would introduce longer-term funding certainty, said Schulz at Berenberg Bank.

“In addition, several governments have put pressure on banks to use the ECB funds to buy sovereign debt, removing some of the stigma. Due to the interlinkage between banks and their governments, banks could potentially save themselves by saving their sovereigns,” he said.

The ECB has consistently refused to act as the lender of last resort to the governments, insisting it was up to countries to get their finances in order.

“But it does take this role very seriously for the banks. If the banks form a kind of cartel and extend that help to the governments, the ECB might be helping sovereigns indirectly,” Schulz said.

This was “just what the doctor ordered,” said Commerzbank analyst Rainer Guntermann, who predicted “bond participation” from banks in the tender as they shift out of shorter-dated refinancing operations to the long-term offer.

“The overriding question today is how much banks will demand from the ECB,” said LBBW analyst Ralph Herre.

“If the operation manages to calm tensions on the interbank markets, the yields could fall on sovereign debt in the medium term. The euro could also benefit and rise,” the analyst suggested. — AFP

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